Expectation inflation still in 1%-3% target range

Inflation is expected to have remained in the middle of the
Reserve Bank's 1%-3% target range in December and figures out
tomorrow should not cause the Reserve Bank to change its
plans for rate hikes.

The Reserve Bank is expected to make its first change to the
official cash rate (OCR) in March, possibly April, although
it does have an opportunity later this month to lift the rate
from the current 2.5%.

While inflation for the three months ended December was
expected to have fallen slightly, annual inflation was
expected to have reached 1.5%.

ASB economist Christina Leung said weaker tradeable inflation
was a key feature of the subdued outcome expected from
December. She expected tradeable inflation to have fallen
0.8% in the quarter.

That largely reflected the seasonal fall in fruit and
vegetable prices.

Added to that was the modest fall in petrol and diesel prices
over the quarter, which ASB estimated provided a negative
contribution of 0.2% to the consumer price index (CPI) - the
official measure of inflation.

The continued strength of the New Zealand dollar had placed
downward pressure on the price of imported goods over the
past year, she said.

The Reserve Bank highlighted the dampening influence of the
high New Zealand dollar on tradeable inflation.

However, tradeable inflation had been lower than movements in
the dollar would suggest, largely reflecting modest household
demand, Statistics New Zealand having reported widespread
discounting of imported household items.

''This reflects the increasingly competitive retail
environment, with retailers' margins crunching in over the
past few years as a result.''

More recently, household demand had improved, reflecting
increasing consumer confidence in light of a stronger labour
market and higher house prices.

Market speculation of an OCR increase at the January meeting
had increased in recent weeks, the December CPI being seen as
a ''game changer'', Ms Leung said.

The Reserve Bank's December forecast of a 0.2% fall in the
CPI would still leave annual inflation at 1.4%, still in the
bottom half of the target range.

It was extremely rare for the CPI to surprise by more than
0.5%. Since March 2004, there had been only two quarterly CPI
results which had been 0.5% or more off forecast in either
direction, while two others had surprised by 0.3% to 0.5%.

Ninety percent of quarterly results had differed less than
0.3% from market expectations.

''In fact, markets have had a tendency to overestimate the
CPI, particularly over the past two years,'' Ms Leung said.

ASB saw the risks to its inflation forecast as fairly
balanced, she said.